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QUESTION 3 Baze University is evaluating two investment projects, as follows. Project 1 This is an investment in new machinery to produce a recently-developed product. The cost of the machinery, which is payable immediately, is $1:5 million, and the scrap value of the machinery at the end of four years is expected to be $100,000. Tax-allowable depreciation can be claimed on this investment on a 25% reducing balance basis. Information on future returns from the investment has been forecast to be as follows: Year 1 2 140,00 Sales Volume (unit/Year) 50,000 95.000 0 75,000 Selling Price (S/unit) 25 24 23 23 Variable Cost (S/unit) 10 12 12.5 105,00 115,00 125,00 125,00 Fixed cost (year) 0 0 0 0 This information must be adjusted to allow for selling price inflation of 4% per year and variable cost inflation of 2.5% per year. Fixed costs, which are wholly attributable to the project, have already been adjusted for inflation. Baze pays profit tax of 30% per year one year in arrears, Project 2 Baze plans to replace an existing machine and must choose between two machines. Machine I has an initial cost of $200,000 and will have a scrap value of $25,000 after four years. Machine 2 has an initial cost of $225,000 and will have a scrap value of $50,000 after three years. Annual maintenance costs of the two machines are as follows: Year 1 2 3 Machine1($/year ) 25,000 29,000 32,000 35,000 Machine 2($/year ) 15,000 20,000 25,000 Where relevant, all information relating to Project 2 has already been adjusted to include expected future inflation. Taxation and tax-allowable depreciation must be ignored in relation to Machine 1 and 2 other information. Baze has a nominal before-tax weighted average cost of capital of 12% and a nominal after-tax weighted average cost of capital of 7%. Required: Calculate the net present value of Project 1 and comment on whether this project is financially acceptable to Baze University

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